subject: Two Things To Know Before You Buy Into A Private Business [print this page] When people buy a business or partial ownership of a business, they desire two ownership traits. One is control or the ability to make the business decisions. Some of the things you can do when you own a controlling interest in a business are listed below.
1. Choose the company's products and services.
2. Choose the company's markets.
3. Choose if you want to give dividends or bonuses.
4. Choose to sell the business.
5. Choose suppliers.
6. Choose how to spend the money.
7. Choose to stop any of the items listed above.
Having a controlling ownership of a business is like being the captain of your own boat. You decide how fast or slow the boat goes. You also decide where to go and when to leave the dock.
Without control, you are just a passenger. If you don't like where the boat is going, you have limited options. You can let the captain know where you want to go, but he or she may not change course. You can also jump ship (i.e. leave the business).
The second trait is the ability to sell your stock in the company in manner which is quick and reliable. This is called marketability. If you owned stock in a publicly traded company like Wal-Mart and wanted to sell it, you would have cash in your account within three business days. This is usually not the case with stock in privately held businesses. It typically takes a lot longer than three business days if you want to sell your stock.
Now here is the critical question. Would you pay $100,000 to own a 10% interest in a privately held business worth $1 million dollars? Your answer should be no. Because a minority ownership interest in a privately held business lacks both control and marketability, the 10% ownership interest value is worth less the prorata share of the business. It is worth less than $100,000. How much less? Well, that depends on the specific business and ownership characteristics.
Studies have been done in the markets to measure control premiums and marketability discounts. The empirical data show a wide range of values. One study, the SEC Institutional Investor Study, had marketability discounts up to 80%; however, the middle range of discounts were between 25% and 45%.
I would expect you to argue that the discount should be low if you are trying to sell your stock. If your partner wanted to sell you his or her stock, I would expect you to argue that the discount should be at the high end of the range. Until a comprehensive business appraisal is performed, it is hard to say how much of a discount is applicable to your specific stock. It is easy to say however that the discount rate used will have a significant impact on the value. This impact can reduce the value by thousands or even millions of dollars.
by: Joseph Phelon
welcome to Insurances.net (https://www.insurances.net)
